What is a 'Declining Balance Method'
A declining balance method is a common depreciation-calculation system that involves applying the depreciation rate against the non-depreciated balance. Instead of spreading the cost of the asset evenly over its life, this system expenses the asset at a constant rate, which results in declining depreciation charges each successive period. For example, if an asset that costs $1,000 is depreciated at 25% each year, the deduction is $250.00 in the first year, $187.50 in the second year, and so on.
BREAKING DOWN 'Declining Balance Method'Depreciation is an accounting convention that attempts to better match expenses to the revenues they produce. That is, accountants want to make sure that the assets purchased today are expensed as they are used, rather than only on the day of purchase. Some expenses, such as office supplies and inventory, are expensed in the year they are purchased because they are used in the same year. Other items, such as a truck, can provide value for more than one year. These assets are referred to as capitalized assets and capitalized assets are treated differently on the balance sheet and income statement. Capitalized assets are not fully expensed in the purchase year, they are depreciated over the life of the asset. One depreciation method used to estimate the amount to depreciate each year is referred to as the declining balance method.
Accountants generally base the declining balance method on the straight-line method. Under the straight-line method the accountant estimates depreciation expense by subtracting the salvage value from the cost of the asset and then dividing by the useful life of the asset. The salvage value is the value of the asset after its useful life, which may also be the scrap value. The cost of the asset is the cost to purchase, and the useful life is the expected life expectancy of the asset, which is generally provided by the manufacturer. If a company purchases a truck for $15,000 with a salvage value of $5,000 and a useful life of five years, the annual straight-line depreciation expense is equal to $15,000 minus $5,000 divided by five, or 20% of $10,000.
Declining Balance Method
The declining balance method doubles the depreciation rates. For example, instead of only depreciating 20% of the book value of the asset, the company expenses 40%. As the asset's book value decreases, so does the depreciation expense until the asset is fully written off. Accountants using this method to depreciate a truck believe the truck is more productive in the beginning of its useful life than the end, and therefore more of the truck's value is depreciated in the beginning of the asset's life under an accelerated or declining balance method.